The Looming X Factors To Watch For.

The Global Financial Crisis – the one that turned the investment community and financial markets into headless chickens – is increasingly acknowledged to be on the mend. Truth be told, while there never was a household expenditure crisis it did cause business ‘leaders’ to undergo a crisis of confidence leading to some rather questionable business practices and bringing about some self-inflicted performance pain.

Retail sales have never been higher in Australia – in both volume and value terms. But economic activity in other sectors and a tidal wave of panicked discounting has seen a massive reduction in many retailer’s margins leading to many having skated through the last year on very thin ice as far as retained cash is concerned.

While household consumption is directly related to the customer’s perception of how much they have at their disposal to spend, we are not in any immediate danger of retail reversing its successes at the top line in the near future.

Unless ‘the X factors’ come to town.

X factors are a favourite get out of jail free card for economists used to describe a catch-all bucket of things that could rain on any commercial parade. There are two that we should watch very closely on the next 12 months. Exchange rates and interest rates.

With the currency at unusually high levels, many retailers are using the currency gain as an offset to growing costs and dwindling margins. Were the currency to retreat to historical valuations in the next 12 months, many of these retailers would suffer unsustainable trading performance drops. If you are one of these retailers – hedge now! If you rely on one of these retailers, find out their foreign exchange plans for the next 12 months before you make your own plans.

Likewise interest rates being raised in any dramatic form will have a double whammy effect on retail. Firstly it will hit household’s real disposable income negatively and secondly it will increase the retailer’s funding costs. Again profit and retained cash are hit. While our universal central bank view of inflation will come under serious challenge in the next decade as we move from supply driven to demand driven markets and both economic and social policy shifts to more from less, nevertheless in the short term inflation may become a problem.

Not the least of which is because governments everywhere have spent way more than they have and to a great degree not on things that increase productivity – except at the ballot box!

Every retailer should be reducing debt and never listening to another financial advisor ever again who tells them to leverage extensively and grow using significant borrowings. Reduce costs and build risk cover. These two X factors may not happen, but they are the most likely of all the ‘black hat’ opinions to be possible.

Pessimism is out. But prudence is back in. As John Howard said “Be alert but not alarmed!”